How can traders minimise their average losses and maximise their profits? Toni Hansen explains.

Whenever I talk to other traders about the things that caused them the most frustration in their first several years of trading, this very same dilemma seems to pop up. Unfortunately, making a large average loss is something that is nearly impossible to avoid at some point in your trading career. A number of things can contribute to it.

In previous issues of YTE I have explored several reasons traders find themselves at this point, by addressing the subject from a technical perspective. One primary cause lies in a trader’s inability to use and correctly place stops, thereby controlling and limiting losses when a trade fails to perform as anticipated. Another cause is being unable to accurately time target levels on a position.

However, even with sound technical reasoning on your side, you might still find yourself treading water. Although those two technical skills are very important to your long-term success, the biggest obstacles you must overcome as a trader are your own emotions, including your ability or otherwise to act upon the technical signals the market offers.

There are a number of different ways to trade the markets. A strong advantage of using a system, or multiple systems, based on technical analysis is that using such a system is a pivotal step in overcoming actions that you might take based only on fear or greed.

When you build a trading system based on technical analysis, you are also building your confidence in that system. One of the first steps that you should take in developing any system is to implement a trading journal. This should not be just a list of the trades you’ve taken, the entries and exits, and profits or losses. Although these can offer you some insight into your trading, such as the times of the day you should avoid, or an ideal time span to trade within, a simple spreadsheet will typically not take you very far.

In order to develop a trading system that you have full confidence in, you must see how that system plays out over time. In order to do so, you will need a more in-depth method for recording the success or failure of acting upon different technical characteristics that arise as you track a trade from beginning to end.

For example, if you are a trader who focuses upon trading range breakouts in a security, then one of the characteristics you are likely to monitor is the volume activity in that security. Over time, you will begin to notice similarities and differences in how changes in volume affect the outcome of a trading range breakout. I have found that if the volume drops off substantially as a trading range progresses, particularly just before a traditional breakout of the trading range, then the odds of success for a strong breakout are much higher than when the volume increases or remains comparable throughout the range. When I see a volume drop during a trading range, it allows me to be more confident than previously about the success of that trade, so I have fewer instances of ‘second-guessing’ the position when an entry is triggered, allowing me to get a better price than I would have if I had hesitated.

When you are able to obtain a better price than anticipated, you can take a larger position while keeping your risk exposure the same. This gives you more contracts or shares to play with, even when you are uncertain of the trade’s potential. You can protect part of your gains early and still have additional contracts or shares to hold on to while you work on your ability to hold for larger targets. Actually holding part of a position into these targets will give you greater confidence to hold an even larger portion of your position the next time you run across the same strategy.

Even though you will start to make connections between things such as volume and price activity naturally over time, your learning improves substantially when you print out charts of your positions showing volume, and compare and contrast winning and losing trades, as well as those that outperform the rest. An observation that might otherwise take years to notice, and even longer to have confidence in, can be recognised and validated in a fraction of that time when you take just a few minutes a day to create a record and then make time to review it.

This style of visual journalling is one of the simplest and most useful sorts of journalling I know. In its basic form, you need only to take a screen shot of the chart upon which your trade was based. I like to show several time spans on one screen, allowing me to go back and see whether or not there was something I missed in another time period that had an effect on the results of my trade. The method can also show other types of support for the position. I mark both my entry and exit times and prices directly onto the chart so they stand out very clearly when I am reviewing them.

Despite the large amount of money you can save by short-cutting the learning process using a visual trading journal, most traders fail to keep one. Risk management and correct target placement will help you advance as a trader, and this knowledge is obtained most quickly through the use of a journal.

So, if you wish to turn around a trend in which your average gain is less than your average loss, then make journalling a part of your daily routine. You will be amazed at how much you begin to notice within just a few short weeks, and how quickly those observations will begin to bring you success.

Toni Hansen is a full-time trader, as well as a popular lecturer and market columnist, who has been sharing her knowledge with others over the past decade. To learn more about Toni‘s methods, go to www.tradingfrommainstreet.com.

This article was originally published in the Mar/Apr 2010 issue of YourTradingEdge magazine. All rights reserved. © Copyright 2011, Your Media Edge Pty Ltd. 
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